Not everyone is cheering the Shome committee's draft report on modification of General Anti-Avoidance Rules ( GAAR). While the recommendations brought a breather to foreign institutional investors, a proposal to compensate the losses from abolition of capital gains tax with a higher securities transaction tax (STT) has spooked small traders and arbitrageurs.

"In short-term capital gains tax, you pay a tax on your profits. With higher STT, traders will pay higher taxes even for their losses. I don't think the markets will like this proposal at all," said Vinay Agrawal, executive director, equities broking, at Angel Broking.

The Shome Committee has proposed to do away with short-term capital gains tax by increasing the transaction tax "appropriately".

Some feel a higher STT will drain liquidity by raising the impact cost for day traders while others said a marginal hike will be offset by increased transactions by investors who otherwise hold on to stocks for more than a year to avoid paying 15% short-term capital gains tax.

"Raising STT at the expense of forgoing capital gains tax is not a good idea," said Kisan Choksey, chairman, KR Choksey Securities. "Under the current tax regime itself, many investors are refraining from accessing the market... abolishing capital gains will further disincentivise them." He added that STT and service tax are the main components of a high impact cost and increasing one of these was neither "feasible" nor "wise." At present, an investor pays STT of 100 per lakh on delivery-based transactions and 17.33 per lakh on the sale of derivatives. Service tax of 12.3% is also levied.

"Daily volumes will be hit big time if the government hikes STT as it would increase transaction costs and, thereby, the impact cost ," said Rahul Rege, business head (retail), Emkay Global Financial Services. "If volumes decline, the government's tax collections by way of STT will also take a hit," he said.

The Committee has argued that fund managers of foreign investors do not have a presence in India as this would constitute a permanent establishment of such investors. Consequently, the business income of foreign investors would be taxed in India. The abolition of tax on portfolio investment may encourage fund managers to shift their bases to India.

In view of this "...the government should abolish the tax on gains arising from transfer of listed securities, whether in the nature of capital gains or business income, to both residents as well as non-residents. In order to make the proposal tax-neutral, the government may consider to increase the rate of STT appropriately."

However, not all brokers have criticised the proposal downright on the premise that abolishing capital gains will put domestic investors on par with their overseas counterparts who are said to trade through tax havens simply to avoid the tax.

"I think this would be a welcome move as it would address the complaints of many investors who cite preferential treatment towards those who access the stock market from Mauritius," said CJ George, MD, Geojit BNP Paribas Financial Services. However, George added a rider that the benefit of this measure would depend largely on the proposed hike in STT. "If the STT hike is too steep it may not have the desired effect....that's key," explained George. "Remember when STT was first introduced (in FY05) investors did not flee the market. But in a bad year like this one very few have made profits so a hypothetical hike in STT will simply end up in their paying tax on losses."